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What’s Next for the Credit Cycle? 

BY TOM FAHEY, CO-DIRECTOR OF MACRO STRATEGIES, AND TYLER SILVEY, CFA, GLOBAL
MACRO STRATEGIST, ASSET ALLOCATION

Key Takeaways

  • Trying to forecast the economy with flip-flopping tariffs and trade policy is like building a house on shifting sands—it’s hard to feel confident without a solid foundation. With more trade talks and 90-day deadlines ahead, we expect significant uncertainty to persist. Attention has turned to the tax and reconciliation bill moving through the US Congress, particularly after Moody’s downgraded its credit rating of US Treasury debt.
  • Even with deals and tariff pauses, the world faces a major step up in tariff rates. It may take time for the impact to show up in economic data. First-quarter reported earnings have been strong, but trade disruption is weighing on the outlook for credit. Profits and consumption are key indicators to watch, in our view.
  • We believe the US economy can avoid a downturn in the near term, but we expect slower growth and higher inflation. Elevated volatility is likely to continue.

CreditCycle-for web_5.22

Graphic Source: Loomis Sayles. Views as of 22 May 2025. The graphic presented is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and, therefore, should not be the basis to purchase or sell any securities. Any opinions or forecasts contained herein reflect the current subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. This information is subject to change at any time without notice.

Volatile Dynamics

In our view, the US economy has been bolstered by strong profits and a strong labor market, which has supported consumer spending. The Federal Reserve appears to be in wait-and-see mode and has paused its cutting cycle. Monetary policy remains restrictive.

Significant policy uncertainty and massive supply disruptions from the tariff shock will likely cause companies to pause or reconsider investment spending. Companies involved in international trade may reevaluate their supply chains. Consumers may pull back on spending as they deal with heightened inflation and economic uncertainty.

We will be watching corporate health very closely. Our most recent survey of Loomis Sayles’ credit analysts (our Credit Analyst Diffusion Indices, or CANDIs), conducted in early April during the height of tariff turmoil, revealed a weakening outlook for corporate health. The Loomis Sayles Credit Health Index (CHIN) is currently at a healthy level consistent with late cycle.

We believe profits are one of the most important indicators to watch because they drive the cycle. If declining demand or increased costs hit margins and profits turn negative, then companies are likely to start shedding labor. A rise in unemployment is a key signal for the downturn phase of the credit cycle.

A Closer Look

In our view, credit cycle analysis requires art and science. We track key economic indicators that tend to behave differently in each phase of the cycle and put them into context using our credit cycle framework and collective experience. Currently, these indicators appear skewed toward downturn, but we believe the credit cycle remains in late cycle based on the strength of bottom-up fundamentals. At this stage of the cycle, investors tend to focus on capital preservation and moving up in quality.

Credit Cycle Table1_5.22

Table Source: Loomis Sayles. Views as of 22 May 2025. Highlighted cells represent attributes we’re currently observing. Green represents our current view. Bright blue represents the previous view (if different from the current view). Arrows indicate the direction of change in view where applicable. The table presented is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and therefore, should not be the basis to purchase or sell any securities.

What’s Next?

Because macroeconomic factors don’t always behave as expected, we prepare scenarios for the path of the US credit cycle over the next six months. Here, we outline three potential scenarios and indicators to watch:

Base Case
Late Cycle/Stallflation

  • In this scenario, the economy shifts toward the edge of late cycle, but does not slip into recession.
  • Stagflation gets talked about a lot, but we believe that term implies a 1970s scenario with a much more bearish shading to inflation, unemployment and asset prices than what we currently anticipate. We prefer “stallflation” for this scenario because we see real GDP growth slowing toward “stall speed,” around 0% - 1%, as the economy adjusts to a historically high tariff rate.
  • Fears of trade war escalation recede, but volatility and uncertainty continue.
  • Earnings growth slows down, but companies entered this period with solid profitability, which should help to limit layoffs.
  • Inflation ticks up while unemployment only drifts marginally higher, preventing the Fed from cutting too aggressively.

Alternative Scenario
Late Cycle/Off-Ramp

  • This scenario acknowledges the potential for strong risk appetite if an enduring off-ramp from the trade war emerges. Potential off-ramps include significant trade deals or court action.
  • Potential tax cuts could provide relief for markets around mid-year, but may also drive bond yields higher.
  • Growth stabilizes at or above 1.5% annual real GDP growth, profits remain strong and unemployment stays low.
  • Inflation moves higher as baseline tariffs stay in place and the strong labor market prevents demand destruction. The Fed stays on hold.

 



 

Alternative Scenario
Downturn

  • In this scenario, profits go negative or undershoot consensus expectations by 10% to 15%, leading to layoffs and a sharply higher unemployment rate above 5%. A rise in the unemployment rate is a lagging indicator, but it defines a recession.
  • Uncertainty remains elevated and many companies pause investment plans. Consumer confidence is poor and the wealth effect would fade as equity markets drop; spending pulls back.
  • Inflation rises in the near term, but demand destruction ultimately levels it out. Risk appetite plunges and the Fed cuts.

 

 

 

 

Macro Themes in a Flash

Our views on key topics that can influence the credit cycle. 

The US Consumer

Our view: Overall consumer spending in the US should slow from very elevated levels. The consumer is still a positive driver of economic growth.

The details: Higher-income households continue to spend at favorable rates. Lower-income households, a much smaller segment of total spending, are showing weakness.  

Global Growth

Our view: We anticipate a global slowdown driven largely by trade frictions, though it’s uncertain how the global economy will absorb the shocks. Encouragingly, many countries are able to respond with increased fiscal spending to become more resilient without the US driving consumer demand.

The details: We expect countries to forge new trade relationships and reroute supply chains. We might be surprised at how fast these can develop. The US may become vulnerable as the US importer or consumer bears the brunt of the tariff burden. The weaker US dollar may be reflecting these shifts.

US Monetary Policy

Our view: While the timing is uncertain, we anticipate further rate cuts.

The details: We expect inflation to continue its disinflationary trend after a temporary jump from tariffs. We think the Fed probably has enough confidence in the disinflationary trend that it would respond to a rise in the unemployment rate with further rate cuts.

US Corporate Profits

Our view: First-quarter earnings growth was very strong, handily beating expectations. Consensus expectations for 2025 have slid to the mid-single-digits, which we think is achievable.

The details: We believe earnings growth can broaden out across sectors later this year, but near-term challenges persist, particularly for energy and materials. Mega-cap tech EPS growth is slowing, but consensus still expects double-digit growth year over year. We believe “rest of market” EPS growth will be challenged near term.

US Credit Risk Premium/Risk Appetite

Our view: Credit spreads have tightened and risk premium has compressed rapidly after the initial tariff shock sent both wider. We expect volatility ahead.

The details: Tight credit spreads have led us to look for value in other segments of the fixed income markets. We would view further spread widening as an opportunity because all-in yield remains attractive.

Inflation

Our view: Tariffs should interrupt the disinflation trend.

The details: Goods inflation is moving upward given the tariff shock, but we expect services to remain better contained. We are seeing a cooling labor market, which could contribute to softening wage growth. If the unemployment rate moves higher as we expect, we believe inflation will ultimately resume its downward trend, allowing the Fed to lower interest rates.

The US Dollar

Our view: We believe the US dollar is overvalued; it appears the US administration would welcome a weaker dollar.

The details: We are seeing consensus growth expectations for the US get marked down relative to other countries. Many countries may fear capital barriers are next and may decide to bring their capital home, which would have a weakening effect on the US dollar.

China

Our view: The effective US tariff rate on China has been reduced to approximately 40%, which we view as a manageable, non-prohibitive level.

The details: The 90-day suspension window could prompt further front-loading of shipments and production, helping to alleviate tariff-related drags on China’s growth. We believe Beijing is less likely to pursue additional stimulus, taking a wait-and-see approach instead. Overall, we believe a durable resolution remains challenging.

Geopolitics

Our view: As hot wars cool down in Ukraine and the Middle East, trade wars are now exploding onto the scene.

The details: We think hotel rooms will be scarce in the Washington, D.C., area as global policymakers make their way to the US capital to negotiate deals to alleviate tariff penalties.

Disclosure

All insights and views are as of 22 May 2025, unless otherwise noted.

This marketing communication is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein, reflect the subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis does not represent the actual, or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice.

Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index.

Commodity, interest and derivative trading involve substantial risk of loss.

Any investment that has the possibility for profits also has the possibility of losses, including the loss of principal.

Markets are extremely fluid and change frequently.

Past market experience is no guarantee of future results.

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Tom Fahey
Co-Director, Macro Strategies, Portfolio Manager